Investing for the next decade

When it comes to inflation and interest rates, the ‘new normal’ of the 2020s might look more like the ‘old normal’ which preceded the 2008 global financial crisis.

TAKE INFLATION, FOR EXAMPLE…

When it comes to the outlook for economic growth, there are significant forces working in both directions which may partially offset one another. On the negative side, we can say with some confidence that demographics will be an increasing headwind as the growth of working-age populations slows globally. This is a particularly significant challenge in China.

DEMOGRAPHIC HEADWINDS TO GROWTH

One obvious way to slow the growth in demand for building materials, and related emissions, is to design buildings to last longer.

BUILT TO LAST

As global temperatures rise and more and more people move into urban centres, demand for air conditioning looks set to boom.

AIR CONDITIONING: A BLIND SPOT

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Figure 2: Global air conditioner stock (1990—2050) - Millions of units Several factors have combined to drive growth in demand for air conditioning in developing countries. As workers move into cities, prosperity is rising, and so it the demand for cooling buildings: more comfortable temperatures mean more productive workers.

Figure 3: Cooling the world - Global CO2 emissions associated with space cooling energy use by source Associated CO2 emissions could rise significantly because air conditioning units are primarily powered by coal–fired power stations in the countries using the most air conditioning.

BUT WE’RE NOT TALKING ABOUT A RETURN TO THE 1970’S

RETROFITTING

MODULAR HOMES

These are much better for the environment than other traditional materials such as copper pipes. There are several reasons for this: they can be made with recycled plastic (which can itself be recycled), they are easier and cheaper to transport and they have a longer life.

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Source: IEA, The Future of Cooling

Source: US Department of Commerce

INFLATION AND RATES: HIGHER AND MORE VOLATILE, BUT NO 1970S

We expect it to be higher and more volatile over the coming decade than it was in the 2010s, more like the ‘typical’ experience of history, for several reasons:

Building houses in a factory allows greater precision, which makes them more energy efficient compared to homes built onsite using traditional methods. Materials are used more efficiently in factory production, with less waste generated, adding to the environmental benefit of modular versus traditional house building. And with labour and materials prices rising, there is also potential to lower costs.

PLASTIC PIPES

But the reality is that existing building stock will still represent the majority of floor space in 2050, so meeting ‘net–zero’ targets for reducing global emissions will mean ‘retrofitting’ them to higher energy efficiency standards. This will be expensive, and is currently unaffordable, but some interesting developments are enabling renovations to be financed by future cost savings on energy and maintenance.

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WHAT WILL THE MARKETS LOOK LIKE AS THE SHOCKS OF COVID AND THE UKRAINE INVASION FADE?

We think this economic regime change will drive a corresponding change in the behaviour of bonds in particular. We see them having a larger role to play in long-term portfolios, although we do still see equities delivering attractive returns, well above inflation. But within equities, the US dominance that has characterised the last decade and a half will fade.

WHAT WILL THE MARKETS LOOK LIKE AS THE SHOCKS OF COVID AND THE UKRAINE INVASION FADE?

When it comes to inflation and interest rates, the ‘new normal’ of the 2020s might look more like the ‘old normal’ which preceded the 2008 global financial crisis.

INFLATION AND RATES: HIGHER AND MORE VOLATILE, BUT NO 1970S

We expect it to be higher and more volatile over the coming decade than it was in the 2010s, more like the ‘typical’ experience of history, for several reasons:

TAKE INFLATION, FOR EXAMPLE…

The risk of another geopolitical shock temporarily pushing up inflation around the world seems significant.

BUT WE’RE NOT TALKING ABOUT A RETURN TO THE 1970’S

Our projections for inflation are higher than 2010s levels, but not dramatically so.

Climate change could drive greater frequency of extreme weather events, which may also contribute to greater volatility in inflation.

The pandemic accelerated deglobalisation and the fracturing of the global economy into regional blocs. This could still contribute to inflationary pressures at the margin.

The belt-tightening of the 2010s seems to be over. Household finances are far healthier now, and governments have re-discover their appetite for spending on activist fiscal policy.

DEMOGRAPHIC HEADWINDS TO GROWTH

ON THE POSITIVE SIDE, WE’RE SEEING A REVIVAL IN PUBLIC INVESTMENT

A key feature of the 2010s was very weak state support for investment in advanced economies. That’s changed since the pandemic, with support for investment into infrastructure and strategic sectors like energy and semiconductors ramping up. Overall, we’re projecting that economic growth will be a little weaker than in the 2010s.

SO WHAT DOES THAT ALL MEAN FOR YOUR INVESTMENTS?

The problem we face as long-term investors is that much of what the future holds is fundamentally unknowable and therefore unpredictable, but we cannot avoid making judgments about it. We’ve tried to draw out three simple and relevant features of the changing investment landscape that we can have some confidence in, even if we can’t foresee exactly what will happen.

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Higher rates

Bonds

equities

As noted above, inflation and interest rates are both likely to be higher and more volatile in the coming decade than they were in the 2010s. Not a repeat of the 1970s, just a return to more ‘normal’ historical levels after the extreme lows of the years after the global financial crisis.

Diversifying assets

Inflation and interest

The long-term returns available from bonds have jumped, as yields have risen substantially. But their volatility has probably also increased. We can’t rely on safer bonds alone as an offset to equity risk, so diversifying assets (like gold and selected hedge fund strategies) remain vital for mitigating risk while preserving returns.

Fading dominance

Equities still appear capable of delivering returns well in excess of inflation. But the distribution of returns within equity markets is likely to look quite different to the past ten years, with the remarkable dominance of the US fading.

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The first few years of the 2020s have been characterised by huge shocks to the global economy – from the pandemic to the Ukraine war. When the dust settles, we think the global economy will have changed in significant ways, and the investment strategies that fared best over the past decade won’t be the ones that serve us best for the next one. If the 2010s are gone for good, we’ll need a different approach.

MEET THE NEW NORMAL, SAME AS THE OLD NORMAL

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Investing for the next decade

MEET THE NEW NORMAL, SAME AS THE OLD NORMAL

Investing for the next decade

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